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Monday, March 21, 2005

JAPANESE PERSPECTIVES

Stock, flow of economy provide key insight into monetary policy


More attention is being focused on Japan's monetary policy, given the changing economic environment at home and overseas.

The recovery is losing its steam, total outstanding government bonds have reached 770 trillion yen, and interest rates can't be raised without further straining state coffers and causing losses for holders of those bonds.

Record-high oil prices are raising inflationary concerns, while the Federal Reserve has raised U.S. interest rates six times since last year. Japan, meanwhile, has kept its so-called "zero interest rate" policy in place for 42 months.

In assessing the future course of the Japanese economy, it is essential to get a clear and well-balanced picture of its "flow" and "stock."

While these may be elementary economic terms to some, it is useful to examine them in terms of value.

On March 10, the Cabinet Office released the annual table of national economic data, which, in addition to statistics on the flow of Japan's economy, contains comprehensive calendar year-based figures on its stock.

The table is normally released in December to reflect data from the end of the previous year, but the latest table was delayed because of revisions in the calculation format and some retroactive data adjustments.

You can get a clear picture of Japan's asset-inflated "bubble" economy by comparing the latest data from the end of 2003, 1989 (when the bubble hit its peak and the Nikkei average nearly hit 40,000) and 1986. The bubble was triggered by monetary easing taken to deal with the negative impact of the dollar's sharp decline following the signing of the Plaza Accord in fall 1985.

The table divides assets into real and financial assets. Due chiefly to the fall in land prices, real assets fell 636 trillion yen from 1989. This means the nation lost real assets equivalent to 125 percent of its nominal gross national product in 2003.

As for financial assets, the aggregate value of securities dropped by 328 trillion yen due to the stock market slump. However, the table shows that overall financial assets rose by 1.027 quadrillion yen.

The gap between these two categories represents the root of Japan's nonperforming-loan problem. The value of a real asset like land plots, for example, purchased at their highs by people who borrowed from financial institutions, has dropped over the years, whereas the value of financial assets, including outstanding bank loans, does not reflect the effect of falling land prices.

The table also shows that the economy's net wealth -- or assets minus debts -- fell by 511 trillion yen from 1989. That figure is roughly equivalent to the nation's annual GNP, which measures the flow of the economy.

The stock, which was equivalent to 790 percent of GNP in 1989, fell to 540 percent of GNP in 2003.

In a comparison with 1986, however, the table indicates that the aggregate value of land stock at the end of 2003 was roughly the same as it was in 1986. In macroeconomic terms, this means land prices have returned to the level they were at when the bubble started forming.

Financial assets meanwhile show an increase of 2.429 quadrillion yen compared with 1986. Net wealth, on the other hand, rose by only 603 trillion yen -- meaning it took Japan 17 years to boost its net wealth by the equivalent of one year's GNP.

This is what we have nearly two decades after the rise and fall of the bubble.

It must be noted here that these comparisons only show that the domestic economic bubble that expanded beyond the realm of substance has finally returned to its original condition. The international economic environment has radically changed over the years, and Japan is being exposed to greater competition with developing economies.

It is often said that the primary objective of Japan's current monetary policy is to pull the nation out of deflation. However, the prices of Japan's stock economy -- particularly land prices -- are still high by international standards, even in the wake of the bubble's collapse. This is evidenced by the fact that Japanese firms continue to expand manufacturing operation overseas.

Japan must steer monetary policy with a full grasp of not just the flow, but the stock of its economy -- while keeping an eye on the direction of domestic prices and how they compare internationally.

Teruhiko Mano is a professor at Seigakuin University.


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